This case study looks at how a RIO could be used to pay off an interest-only mortgage.
Ken and Judy, 58 and 59; both working as teachers.
This case study does not represent real people and is for illustrative purposes only.
Ken and Judy’s story
Ken and Judy are 58 and 59 respectively and are both working as teachers in West Malling, Kent.
Now their children have grown up, they finally lead a more comfortable life, and their joint income allows them to indulge in their passions, like travelling, cycling and spending time with their friends and family. Before this, they were spending a lot of money on education fees, which helped their children graduate from university with minimal debts.
Their biggest financial concern is the outstanding mortgage on the property they bought 20 years ago. As money was tight, they bought it using an interest-only mortgage and have never arranged a capital repayment plan. The mortgage term ends in 9 months’ time, and they are not sure how they will repay the outstanding capital of £140,000. The property is a three-bedroom semi-detached house and is now worth £440,000.
What they want
- Find a solution for their interest-only mortgage that is due to mature in 9 months’ time.
- Stay in the home they have lived in for many years, and remain close to their friends.
- Borrow £170,000 to clear the existing mortgage, travel, and treat their family.
- Leave an inheritance for their children and grandchildren.
Ken and Judy have spoken to a mortgage broker who was recommended by a friend, to ask about their options. They are aware of the increase in value of their home and do have the option to move out, downsize or move somewhere a little further out. However, they are keen to remain in their home so they can enjoy their retirement with friends close by. They would also like the house to form part of the inheritance they leave for their family.
They are aware of rising interest rates and would like the certainty of having a long-term fixed rate to manage their monthly payments. They understand they are approaching retirement and would like to know if both their state pensions and public sector pensions combined are enough to continue making monthly repayments; without causing any detriment.
table Assets Expected outgoings
House value: £440,000
Outstanding mortgage: £140,000
Ken's annual income before tax: £27,000
Judy's annual income before tax: £24,000
Ken’s gross pension £18,000 plus State Pension £9,600
Judy’s gross pension £15,000 plus State Pension £9,600
Interest only mortgage: £350 a month
Living expenses: £1400 a month
Ken and Judy have the means to pay the interest on their mortgage but not the outstanding debt.
They could use a Retirement Interest Only (RIO) Mortgage with a fixed interest rate for life.
Their joint final salary pension payments are guaranteed, so they will have the security of knowing that they can cover the payments throughout their retirement. Even if Ken, whose income is higher, dies first or goes into long term care, Judy’s state pension and government supported pension scheme when she retires would provide enough income to support her monthly outgoings.
Under our current RIO Mortgage, Ken and Judy would be able to borrow £107,700 costing £367 per month1. However, they can afford repayments up to £700 per month. Our new loan to income (LTI) caps on a RIO Mortgage allow Ken and Judy to borrow £170,000 at a cost of £579 per month1, which is lower than the £700 per month they can afford to repay.
Benefits for Ken and Judy
- They can pay off their outstanding mortgage, stay in their home, and use the rest of the money to travel and treat their family.
- The certainty of a fixed interest rate for life.
- Their available income streams mean they can afford the repayments on a RIO and pass the affordability test.
- As Ken and Judy are keen to leave an inheritance, a RIO may suit them better than a Lifetime Mortgage.
- Based on their ages, they could borrow more with a RIO than they could with a Lifetime Mortgage based on our current criteria.
Your client should think carefully before securing other debts against their home. As a last resort, their home may be repossessed if they don't keep up repayments on their mortgage.
Their ability to make the payments may be affected if:
- Their income falls in the future.
- Their expenditure increases in the future.
- Inflation reduces the purchasing power of their income.
Taking out a mortgage in later life could limit their future choices too. For example:
- It might affect their family's inheritance when they die.
- They may not be able to afford any additional care needed in later life.
- Their future choices in moving home could be limited.
- Opportunities to borrow from other sources could be limited.
- If the loan is for life, they'll repay the loan from the proceeds of the sale of their home when the last borrower enters into long-term care or when they die.
1Assumptions: (4.75 x £39,975k – the lower of her salary (£75k), pension pre-state pension age (85%*£3,500 + 85%*£20,000+£20,000 – assuming one of the final salary benefits and defined contributions pot will not be escalating, and one final salary pot will) and pension post-state pension age (pension pre-state pension age +£9,600).
2Based on an interest rate of 4.09% accurate as of 8 April 2022. Subject to change.